To date, the literature does not explicitly address financial services firms
outside the insurance sector. There is emerging evidence that some investors
or businesses as a group are modifying their risk perception to incorporate
the potential for climate change. Partly this is driven by pension funds that
are filing shareholder resolutions against polluting companies or banks that
finance such practices (Behn, 2000). Similarly, there also is emerging evidence
that financial services firms are including consideration of potential climate
change as a risk factor in evaluating investments or developing new products
(World Bank, 1999; Jeucken and Bouma, 2000). However, history has shown that
the ability of banks and asset management firms to respond and adapt to external
shocks is strongly tied to the ability of those institutions to diversify risk,
both for themselves and for their customers. Over the past 25 years or so, financial
services firms have changed significantly in response to a variety of circumstances,
including macroeconomic disturbances of local and global proportions, advances
in communications and information technologies, and changing regulatory regimes
(Kaufman, 1992; Downing et al., 1999). Several types of tools can be
identified for managing risk: improved information and research, diversification,
building up reserves, and new product development.

The Role of New Product Development

Over the years, banks as a whole have demonstrated their ability to continuously
develop new products and services to respond to changes in their own business
environment as well as the changing needs of their customers (Folkerts-Landau
and Mathieson, 1988; Haraf and Kushmeider, 1988; Jeucken and Bouma, 2000). The
ability of those firms to respond and adapt to any impacts of potential climate
change will be determined largely by their ability to identify any changes in
their customers' views of asset risk and to develop new products to hedge
and diversify that risk. Again, the literature does not discuss explicitly which
specific existing products might be useful in responding to changes in risk
stemming from potential climate change or what types of new products might be
developed to respond to such potential changes in risk. However, the industry
continues to apply basic conceptsincluding options, swaps, and futures
contractsin new and different ways to create new products that provide
investors and businesses with useful tools for reducing well-known and understood
risks (Mills, 1999, Vine et al., 1999). These products can range from
environmentally and socially screened investment funds to very sophisticated
derivatives that hedge against weather risks.

In the past few years, such weather derivatives have seen rapidly growing use
to hedge the risks of businesses whose sales and revenues are strongly affected
by the weather. Securitization is becoming more and more widely used as a means
of spreading risk and obtaining resources for investment banking with a secure
flow of income in the future. Financial institutions other than insurance companies
have been developing and offering such instruments in the form of catastrophe
bonds, for example (see Box 8-3).

In summary, the banking industry is more likely to see climate change and the
possible response more as an opportunity than as a threat. In the new global
competition, banks and asset managers are likely to be less concerned about
any possible threat posed to their existing portfolios by weather extremes induced
by climate change and more preoccupied with adjusting to a rapidly changing
and increasingly competitive global market in which failure to adjust leads
rapidly to loss of market share and net revenue and a decline in share price
and shareholder value. They have little incentive to try to change the rules,
but they are highly motivated to respond once changes are imminent or implemented.